Sunday, June 24, 2012

Two Nobel price winners try to save the world!

Good morning all and have a nice week. This past Thursday, I had the privilege to attend an event organised by the bank of Cyprus. Professors Prescott and Pissarides, both Nobel prize winners delivered talks about the causes of the recession and possible solutions. I am actually surprised that the event did not gain the attention it deserved in the media. Perhaps, I can start setting things right with this blog entry.

The event was introduced by a representative of the bank of Cyprus. I was quite surprised to hear him talk about the alleged falsification of economic theories as the cause of the recession. I am afraid that the statement was misguided. In fact I could not disagree more.

Professor Prescott was the first to take the podium. He shocked everyone in the crowd when he said that where the European Union is a success, the Euro is actually a failure!! He argued that the new entrants in the EU are catching up to the original founders with respect to production and GDP. This means that they are producing relatively more than the more developed countries. He explained that the cause of the recession is the ageing population and the lack of available places to save.

The ageing population means that people continue to work well after retirement and as a result this causes unemployment in the younger age groups. While I agree with the problems created by the ageing population, I do not consider this to be the cause of the crisis. The problem of the ageing population existed well before the recession and will most likely persist after the recession ends. I will comment on this further in my recommendations.

Prescott also mentioned the lack of good strong financial markets to accommodate savings. Forms of savings are business equity and government debt. But more public debt is not the option because governments are not able to honor large debts.

Prescott finally proposes a solution to reform the tax and finance systems. His argument is based in getting rid of capital income tax. This will cause investment to rise. Also he proposes for the government to sell capital to the private sector and then leasing it back.

Financial crises are symptoms not a sign of bad economic times. Prescott believes that macro theories work contingent that several conditions are met.

Professor Pissarides recognised the cause of the recession to be the collapse of the financial system beginning with the failure of the Lehman brothers. In a sense he agreed that there is a lack of good places to save and identified the problem of the ageing population.

He argued that the tourism sector in Cyprus is not going to develop further and that the only thing Cyprus can do is increase the quality of service. Development will occur in the health and financial sectors and this is where the government needs to focus.

Finally he said that abolishing the capital income tax is not politically possible because this will cause a redistribution of income where the rich will get richer. Restructuring the economy with the entrance of private investors is a good solution for the long run however it will not have any short term effects.

Having heard both arguments and recommendations I will respectfully put forth my own. I do not believe that one person alone holds the answer to the problem. For me, it is no secret that I am in favour of restructuring the economy. This was my recommendation in a previous post.

I do not consider the Euro to be a failure. Actually I do not think it is possible to differentiate between the European Union and the Euro as they both represent the will of the member states towards a unified economic entity. The Euro can still exist even if decentralization occurs.  

I consider the failure of the financial system to be the cause of the recession. This is mostly because of negative speculation and lack of investments. I propose to take immediate measures to gain investor confidence by insuring bank deposits and decreasing interest rates to encourage investments. Further, I am in favour of abolishing the capital income tax as it was proposed by Prescott. Even though this will lead to an income redistribution in favour of the rich, we must not loose scope as to who actually invests. Abolishing capital income tax will undoubtedly lead to an increase in investment.

I also propose as a long term solution to proceed with the restructuring of the economy as soon as possible. This will have several advantages in the future and will deter future recessions of this magnitude. The restructuring should invite the private sector to take on the role of public service provider. I do believe that a combination of the proposals we heard on Thursday can go a long way to help the economy.

Have a high utility day.


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